The Death Knell of the Economic Recovery

Call it the "shot heard round the world." Its aim was ostensibly to reduce
the U.S. budget deficit, its effect was tantamount to a bullet in the chest
of the consumer recovery.

Last week the U.S. working class was hit with a significant payroll tax increase,
a blow which couldn't have occurred at a worse time. Just as the economic recovery
was starting to gain some traction, our elected officials took the proverbial
wind out of its sails by raising taxes. A tax increase is the last thing needed
when the economic undercurrents are deflationary, as they are now. This measure
will eventually beget even more deflation as consumers reign in spending once
they see their paychecks diminished courtesy of the U.S. Congress.

Reading through scads of news articles and blog postings pertaining to the
tax hike, I'm amazed at the lack of outrage among its victims. Few seem to
realize the enormity of the situation: a $100/month paycheck cut is coming
for many wage earners in the U.S. this year, yet few seem to grasp the implications.

To put into perspective just how much $100 a month is for the typical American,
let's look at the expected cost of living increases for the coming year. Along
with smaller paychecks because of Social Security and healthcare deductions,
Americans also face higher grocery bills. Retail food costs for 2013 are projected
to rise 4 percent, according to AOL Daily Finance. That adds up to about $40
a month for the average family.

Health care premiums will rise by $20 a month, once the new rates are implemented
in February. Internet service will increase by $2 a month as service providers
raise rates once again. Cable TV will also go up $5 a month due to rising rates. "This
means your total expenses could be $70 a month higher this year, assuming gas
prices remain the same, and do not exceed $4 a gallon," observes John Matarese
of EW Scripps Co.

For even more perspective, consider the findings of a recent study by the
Center for Responsible Lending: the typical American has only $100 after monthly
expenses. The study found, "After controlling for inflation, the typical household
had less annual income at the end of 2010 than it did at the beginning of the
decade. Moreover, as worker productivity increased, the workplace has seldom
rewarded them with higher pay."

The study went on to say that the combined effect of stagnant wages, unemployment
and under-employment is forcing many families to curb spending and use any
available assets to remain financially solvent. It concludes with this warning: ""In
order for the U.S. economy to grow again, individual households must find themselves
in a position to increase their spending. This will be difficult as long as
households continue to face stagnant incomes, increasing expenses, increasing
levels of debt, and declining net worth."

It's not a stretch then to surmise that the the tax hike represents at least
one nail in the coffin of the U.S. consumer's recovery. Much of what Wasington
has done in the last four years to revive consumer spending has been sacrificed
by this thoughtless act. The "self-inflicted wound" the president spoke of
before the vote has become reality.

The bi-partisan tax hike also undermines the claim by Congress that lowering
the unemployment rate is its top priority. As Sal Gentile observed in an MSNBC
article, "The political class has apparently convinced itself that unemployment
is no longer a problem, despite the fact that only 58% of Americans have jobs,
essentially the lowest number since 1983 and virtually unchanged since the
end of the recession." The expiration of the payroll tax cut will likely make
it worse. Writes Gentile, "According to the Congressional Budget Office, the
payroll tax cut did much more to stimulate the economy than income tax cuts,
because most households pay more in payroll tax than income tax."

Adding insult to injury, whatever money was earned for deficit reduction as
a result of the tax hike was immediately squandered. As Gentile wrote, "The
payroll tax increase, it turns out, will save about $95 billion in 2013 alone.
But Congress turned around and gave most of that savings away in tax breaks
for businesses like NASCAR, Hollywood studios and Wall Street. The Joint Committee
on Taxation estimates those so-called 'tax extenders,' tucked into the bill
with little notice, will cost $68 billion in 2013."

Despite what members of Congress may think, it's the middle class that is
the backbone of the U.S. economy. Responding to the problem of diminished tax
revenues by raising taxes on the those already financially distressed won't
do anything to solve the government's fiscal problem. Lowering taxes on middle
wage earners would have been the more sound approach.

Socialism's last stand?

Credit David Knox Barker (www.LongWaveDynamics.com)
with this interesting observation: "Even the New York Times recognizes
the lousy job government does in spending the taxes it collects. The flight
from France after tax increases is increasing the conversation on whether government
has gone too far. The article concludes, 'No matter how high the taxes, there
is never enough.' In France and the U.S., the tax grab and will evoke its own
reversal."

The future of inflation

Despite the clear deflationary implication of Congress' latest act, many on
Wall Street are actually worried about inflation.

"It's Not Too Early to Worry about the End of Fed Easing" proclaimed one recent
news headline. The article was written in response to the release of the minutes
from the U.S. Federal Reserve's latest meeting which were released last Thursday.
The minutes revealed that Jeffrey Lacker, Richmond Fed Bank President, is concerned
that the Fed's bond-buying stimulus plan will eventually stoke inflation.

"It is unlikely that the Federal Reserve can push real growth rates materially
higher than they otherwise would be, on a sustained basis," said Lacker. "I
see an increased risk...that inflation pressures emerge and are not thwarted
in a timely way." The minutes showed several members of the Federal Open Market
Committee foresaw a chance that asset purchases would need to be slowed or
halted altogether before the end of 2013.

Just like that, Wall Street has a new worry going forward, viz. the end of
quantitative easing (QE). This is in marked contrast to Wall Street's worry
of just a few weeks ago that the Fed was going overboard with QE. Investors
are now apparently torn between the fear of inflation and the worry that the
Fed's efforts at re-infllating the financial market will end too soon.

A straight forward reading of the long-term Kress cycles tell us that inflation
won't be a major concern until after 2014. The dominant long-term components
of the 120-year cycle, the 40-year and 60-year cycles, will both bottom around
October 2014. The increasing descent of these cycles into late 2014 is expected
to create significant deflationary pressures on the economies of developed
nations, particularly the U.S.

This is one of the main reasons why the Fed's intensive efforts at re-stimulating
the economy through QE have been relatively ineffective. As the following graph
vividly shows, each successive QE has resulted in a less vigorous increase
in equity prices, to say nothing of economic output.

Inflation is also being kept at bay through the deflationary policies of the
U.S. Congress (payroll taxes, Obamacare taxes, etc.) as well as the austerity
policies of other major governments around the globe. The year 2013 will ultimately
tell the tale of whether the Kress deflationary scenario comes to pass. My
best guess is that we'll start seeing an erosion in retail sales by the second
quarter with increasing deterioration in each subsequent quarter. By the end
of the year corporate profits will be in decline, then the real trouble begins
entering the fateful final year of the 120-year cycle - 2014.

2014: America's Date With Destiny

Take a journey into the future with me as we discover what the
future may unfold in the fateful period leading up to - and following - the
120-year cycle bottom in late 2014.

Picking up where I left off in my previous work, The Stock
Market Cycles, I expand on the Kress cycle narrative and explain how
the 120-year Mega cycle influences the market, the economy and other aspects
of American life and culture. My latest book, 2014: America's Date With
Destiny, examines the most vital issues facing America and the global
economy in the 2-3 years ahead.

The new book explains that the credit crisis of 2008 was merely
the prelude in an intensifying global credit storm. If the basis for my prediction
continue true to form - namely the long-term Kress cycles - the worst part
of the crisis lies ahead in the years 2013-2014. The book is now available
for sale at:http://www.clifdroke.com/books/destiny.html

Order today to receive your autographed copy and a FREE 1-month
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Clif Droke is the editor of Gold & Silver Stock Report, published
each Tuesday and Thursday. He is also the author of numerous books, including
most recently, "Gold & Gold Stock Trading Simplified." For more information
visit www.clifdroke.com

Clif Droke is a recognized authority on moving averages and internal
momentum. He is the editor of the Momentum Strategies Report newsletter,
published since 1997. He has also authored numerous books covering the fields
of economics and financial market analysis. His latest book is Mastering
Moving Averages. For more information visit www.clifdroke.com